Surrendering a life interest – beware the tax implications
A common method to ensure that a family member or spouse of a Willmaker will have the right to reside at a particular property for the rest of their lifetime is for the Willmaker to grant a ‘life interest’ to that individual.
The beneficiary who is granted a life interest is known as the ‘life tenant.’
When a life interest in property is granted for the benefit of the life tenant, that property will be held on trust for the life tenant for his or her lifetime. A life tenant will have the right to exclusive possession and enjoyment of the property and is entitled to any income generated from the property.
Following the death of the life tenant, the property is transferred to other specified beneficiaries named in the will (called the ‘remainder persons).
It is common for a life interest to be established by a will and used as part of the estate planning process, particularly in blended families.
For example, a life interest may be desirable when the Willmaker has a second spouse and children from an earlier relationship.
The Willmaker may wish for their spouse to live at home during their lifetime and then ownership of the home to pass to their children upon the
partner’s death.
But what happens if the life tenant no longer wants to hold their life interest and all of the responsibilities that come with maintaining a large property? While the life tenant may rent out the property, the associated expenses and maintenance may exceed the rental income derived. The life tenant may feel that they are in a difficult position as they will not have the right to sell the property, yet they will be responsible for continuing to pay the outgoings on the property and ongoing maintenance.
In these circumstances, a life tenant may choose to dispose of their life interest by ‘surrendering’ that interest. However, in doing so, the life tenant may inadvertently trigger an unexpected capital gains tax (CGT) liability. In certain circumstances, with some forward planning, this undesirable outcome may be avoided.
CGT on surrender of a life interest
The surrender of a life interest by a life tenant can have CGT implications. The Australian Taxation Office (ATO) considers that when a life interest is surrendered, there is a disposal of a CGT asset.
This is because the ATO considers that the surrender of a life interest results in a change of ownership in the life interest from the life tenant to the remainderperson/s, rather than the life interest merely ending. Importantly, where the life tenant receives no consideration for the surrender of their life interest, they are deemed to have disposed of the interest at market value, triggering a potential capital gain (or capital loss).
In order to calculate the potential CGT on the surrender of a life interest, an actuarial valuation will typically be required for the purpose of determining the market value of that interest.
If, however, a life tenant acts quickly and disclaims their life interest following the initial grant of that interest, any CGT implications may be avoided.
If the Will provides for the circumstances where the Trustee and the life tenant can agree to end the life interest before the life tenant’s death, then the life interest is considered to come to an end pursuant to the terms of the Trust and this will prevent the triggering of CGT.
Disclaiming a life interest
Upon being granted a life interest, a life tenant may make a declaration disclaiming their interest. A life tenant may disclaim their interest upon first becoming aware of it without triggering a CGT liability. In these circumstances, the ATO considers that there is no ‘disposal’ of a life interest, as the life tenant is taken to never have acquired it.
However, any disclaimer must be prompt to ensure CGT is avoided. In particular, the right to disclaim an interest will be lost if the right is not exercised within a reasonable time or if the person has engaged in positive conduct indicating an acceptance of their interest. The ATO considers that someone who remains silent beyond the time when they may be expected to disclaim the interest may be presumed to have accepted it.
Accordingly, it will be necessary for a life tenant to act promptly upon being granted a life interest to ensure any disclaimer is legally effective.
Comment
The implications of surrendering a life interest must be carefully considered prior to any active steps being taken to surrender that interest, as the life tenant may trigger an unexpected and potentially significant CGT liability.
Please contact our Tax team if you would like advice on the potential implications of surrendering a life interest, including whether an effective disclaimer may be made or the Wills, Trust & Estates team for advice if you are considering including a life interest in your Will.
| Disclaimer: This publication contains comments of a general nature only and is provided as an information service. It is not intended to be relied upon as, nor is it a substitute for specific professional advice. No responsibility can be accepted by Rigby Cooke Lawyers or the authors for loss occasioned to any person doing anything as a result of any material in this publication.
Liability limited by a scheme approved under Professional Standards Legislation. ©2021 Rigby Cooke Lawyers |